Taxation of Dividend Income under Income Tax Act

The Taxation of Dividend Income under the Income-tax Act, 1961 refers to the manner, timing, and rate at which dividends received by shareholders are brought to tax, depending on the nature of the dividend, residential status of the recipient, and the source company (Indian or foreign). Under the Act, dividend income is generally taxable in the hands of the shareholder and is chargeable under the head “Income from Other Sources” as per section 56(1), unless such dividend is attributable to business income or a permanent establishment in India. With effect from 1 April 2020, the Dividend Distribution Tax (DDT) regime was abolished, and dividends are now taxed at normal or specified rates in the hands of the recipient.

Table of Contents

1. Background and General
2. Taxability
3. Deductions
4. Dividend Income – Foreign Company

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1. Background and General

Shareholders account/hold investments in equity shares as stock-in-trade or investments. The reason for holding the shares as investments is to earn from its growth and from return on that growth. Some of the discussion contained in this chapter has already been referred to in Chapter 4 but for the sake of clarity the same is being reiterated in this chapter.

Such return u/s 56(1) being dividends earned from securities as investment shall be considered under the head “Income from Other Sources”. This is a residuary head of income and seeks to tax such income that does not belong to other four heads namely Salary, House Property, Business Income and Capital Gains. However, section 56(2) brings to tax certain categories of income under this head specifically.

Until 31st March, 2020 (AY 20-21) dividend from an Indian company, was exempt u/s 10(34) of the Act. Simultaneously, a domestic company was required to pay Dividend Distribution Tax (DDT) u/s 115-O. Thus, at that time DDT was paid by the payer company, and receipt of dividend was exempt in the hands of shareholders.

2. Taxability

• Section 8 of the Income Tax Act, 1961 clarifies that for the purposes of inclusion in the total income of an assessee:

1. 1. any dividend declared by a company or distributed or paid by it within the meaning of sub-clause (a) or sub-clause (b) or sub-clause (c) or sub-clause (d) or sub-clause (e) of clause (22) of section 2 shall be deemed to be the income of the previous year in which it is so declared, distributed or paid, as the case may be;
   2. any interim dividend shall be deemed to be the income of the previous year in which the amount of such dividend is unconditionally made available by the company to the member who is entitled to it. Final dividend shall be taxable in the year in which the right to receive is established, i.e. when it is declared at the Annual General Meeting (AGM) of the company.
   3. Deemed dividend u/s 2(22) shall be taxable in the year in which it is distributed or paid by the company.

• The taxation of dividend income shall be chargeable to tax at normal tax rates as applicable in case of an assessee except where a resident individual, being an employee of an Indian company or its subsidiary engaged in Information technology, entertainment, pharmaceutical or biotechnology industry, receives dividend in respect of GDRs issued by such company under an Employees’ Stock Option Scheme. In such a case, dividend shall be taxable at concessional tax rate of 10% without providing for any deduction under the Income-tax Act. However, the GDRs should be purchased by the employee in foreign currency.
• Also, where the dividend is received in respect of GDRs of an Indian Company or Public Sector Company (PSU) purchased in foreign currency, the tax shall be charged at the rate of 10% without providing for any deductions.
• The relevant sections under which different persons will be taxed tax is charged are as under:

3. Deductions

Upto AY 2021-22 deduction of any reasonable sum paid by way of commission or remuneration to a banker or any other person for the purpose of realising such dividend or interest on behalf of the assessee is allowed as a deductible amount against dividend income u/s 57(i). It was held in the case of Ormerods (India) Private Limited v. CIT (1959) [36 ITR 329] (Bom.) that interest on monies borrowed from the purpose of purchase of shares is an expenditure allowable u/s 57(iii), whatever may have been the purpose of the purchase of shares, e.g., even to acquire controlling interest in the company.

After the amendment by Finance Act, 2020 w.e.f. A.Y. 2021-22, the above deduction is limited to interest with a cap of 20% of the dividend income. The benefit for claiming deduction is only available to Indian tax residents. This net income is chargeable to tax at slab rate in case of Individuals and the rates as applicable in the case of another assessee.

A Non-Resident is subject to special rate of tax of 20% of gross dividend u/s 115A of the Act. However, the surcharge is capped at 15% on this. Hence, no deduction will be allowed in computing income by way of dividends received by a foreign company or a non-resident.

4. Dividend Income – Foreign Company

4.1 Dividend Received from a Foreign Company (Receiver Resident Indian)

Dividend received from a foreign company is taxable. It will be charged to tax under the head “income from other sources.” Dividends received from a foreign company will be included in the total income of the taxpayer and will be charged to tax at the rates applicable to the taxpayer.

4.2 Dividend Received by a Foreign Company/Non-Resident (Payer Indian Company)

Dividend Income received by a foreign company from an Indian company is taxable under the ‘head other sources.’  (One exception being dividend is attributable to Permanent Establishment (PE) of foreign company in India). In that case the dividend income may be taxed as Business Income. This will apply to the dividend distributed on or after 1st April, 2020 as prior thereto dividends from Indian Companies were exempt under the domestic law.

Section 4 being charge of tax and section 5 being accrual and arising of income in India apply to the taxability of incomes accruing in India if they are in the nature of income u/s 2(28) of the Act. However, non-residents who are outside India are taxable in regard to dividends paid/payable to them by Indian companies regardless of their situs in India as section 9(1)(iv) gets triggered, dividends paid by Indian company outside India. This assures the taxability of dividends based on deemed accrual and arisal in India.

(Sections 9(1)(iv) read with 5(2)(b) of the Act.)

The taxation of dividend income will be 20% (plus surcharge and cess as applicable). However, the foreign company can claim the treaty benefits of lower rate of tax on dividends, subject to the conditions mentioned in that treaty between India and the country where Investor Company is tax resident.

Section 115A of the Act deals with the provisions related to determination of tax in respect of dividends, royalty and technical fees in the case of non-residents and foreign companies. This would include non-residents, whether Indian Citizens or otherwise. Section 115E is a special provision that applies to non-resident Indians who earn income from specified investments, including long term capital gain. Specified investments are those which have been purchased, acquired or subscribed to in convertible foreign exchange. The rate of tax in both cases is 20% plus the applicable surcharge and cess.

4.3 Relief from Double Taxation

The taxability of dividend and tax rate thereon shall depend upon residential status of the shareholders, in case of a non-resident shareholder, the provisions of Double Taxation Avoidance Agreements (DTAAs) and Multilateral Instrument (MLI) shall also come into play.

As per section 195, the withholding tax rate on dividend shall be as specified in the Finance Act of the relevant year or under DTAA, whichever is applicable in case of an assessee. In case tax on dividend is payable in both the countries by the recipient of the dividend i.e., the country in which the recipient company is incorporated and the country in which recipient is liable for withholding taxation of dividend income, then tax relief can be claimed under the provisions of double tax avoidance agreements read with Multi-Lateral Instruments MLI). This will avoid double taxation to the recipient.

In case there is no such agreement between both the countries, the relief can be claimed as per section 91 of the Act. This means that the taxpayer will not have to pay tax on the same income twice.